Garnaut’s distribution model questioned

Economists are questioning
Ross Garnaut
’s recommendation to distribute the revenue from the carbon tax to those on lower and middle incomes while raising marginal tax rates for those on above-average incomes.

Professor Garnaut during the week backed the idea of using 60 per cent of the revenue from the carbon tax – about $6 billion a year – to compensate households for the expected rise in the cost of living.

He suggested skewing the compensation to those on low and middle incomes in what he has called productivity-enhancing tax reform. He has advocated using two-thirds of the money to lift the tax-free threshold from $6000 to $25,000 and because this would cost more than is raised from a carbon tax, he proposed paying for this by raising marginal tax rates for those on incomes above $80,000.

Professor Garnaut argued in his final report released on Tuesday that tax cuts could be used to encourage more people into the workforce.

He said targeting lower and middle income earners made sense because they responded most to a change in work incentives. While upper income earners would not pay more tax in total, Professor Garnaut said raising the marginal tax rates for those higher up the scale might discourage some people from working more. “There may be a small negative impact on the work incentives for higher income earners by these changes." His proposals are a modified version of the recommendation of the Henry tax review, which suggested a 35 per cent tax rate for those earning between $25,000 and $180,000.

It was rejected because it would have raised the marginal tax rate for many lower middle income earners.

John Freebairn, professor of economics at Melbourne University, agreed low and middle income earners should get more compensation because power costs account for a bigger share of their income and tax rates have a bigger effect on their choice of how to work.

But he said Professor Garnaut’s formula went too far.“You need to compensate those on middle and higher incomes too," he said.

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He proposes spreading the cuts more broadly, raising the tax-free threshold only slightly by $1500 but also cutting the higher rates with the biggest cuts at the bottom. He suggested cutting the lowest rate of 15 per cent to 13.5 per cent and the top rate from 45 to 44.5 per cent.

Adam Creighton, a research fellow at the Centre for Independent Studies, writing in the Weekend Financial Review , called Professor Garnaut’s proposals “blatant populist redistribution". He has proposed leaving the tax-free threshold as is and cutting rates for the existing 15 and 30 per cent tax rates. The government has promised to release its plan for the carbon tax by July.